Repeal Sarbanes-Oxley–Lock, Stock And Barrel

The Sarbanes‐​Oxley Act (SOX) was the most important political response to the collapse of Enron and several other large corporations early in this decade. My own evaluation of this act is much like that by my colleague Alan Reynolds, who described SOX as “unnecessary, harmful, and inadequate.”

Unnecessary–because the stock exchanges had already implemented most of the SOX changes in the rules of corporate governance in their new listing standards, the Securities and Exchange Commission (SEC) had full authority to approve and enforce accounting standards, the requirement that CEOs certify the financial statements of their firms and the rules for corporate disclosure.

The Department of Justice had ample authority to prosecute executives for securities fraud. The expensive new Public Company Accounting Oversight Board (PCAOB) is especially unnecessary. Its role is to regulate the few remaining independent public auditors, but it has no regulatory authority beyond that already granted to the SEC.

Moreover, the audit firms still have a potential conflict of interest because they are selected by and paid by the public corporations that they audit. A much more effective change would have been to have each stock exchange select, monitor and compensate the auditors of all firms listed on that exchange. The PCAOB may also be unconstitutional, because it is a private monopoly that has been granted both regulatory and taxing authority.

Harmful–because SOX substantially increases the risks of serving as a corporate officer or director, the premiums for directors and officers liability insurance and the incentives, primarily for foreign and small firms, not to list their stock on an American exchange. The ban on loans to corporate officers eliminates one of the more efficient instruments of executive compensation. And SOX may also reduce the incentive of corporate executives and directors to seek legal advice.

Inadequate–because SOX failed to identify and correct the major problems of accounting, auditing, taxation and corporate governance that have invited corporate malfeasance and increased the probability of bankruptcy.

What to do?

At a minimum, Congress should clarify that the criminal penalties in SOX require proof of malign intent and personal responsibility for some illegal act. The major potential problem of the act is the awesome threat that senior corporate managers may be held liable for an illegal action that the senior manager did not direct, condone or even know about. No large organization can operate under such a threat.

Congress has wisely refrained from applying this standard to government managers even though the General Accounting Office (GAO) reported in 1998 that “significant financial systems weaknesses … prevent the government from accurately reporting a large portion of its assets, liabilities and costs.”

Any SOX cleanup legislation should address the problem of delisting by foreign and small firms from the American stock exchanges, maybe by exempting such firms from the regulatory requirements. Such delisting reduces both the information about and the liquidity of the firms delisted. The current application of SOX to foreign firms represents a significant extraterritorial extension of U.S. regulations that is also likely to cause other problems.

A wise Congress would also eliminate the expensive new and wholly unnecessary PCAOB, preferably before it establishes new precedents and creates some new special interest. This should probably be accompanied by amending SOX to shift the authority to select, monitor and compensate the independent public auditors from the audit committee of the corporate board to the stock exchange on which the corporation is listed.

A Congress that is both wise and brave would repeal SOX–lock, stock and barrel. Sox adds no necessary authority to those previously granted, creates the potential for substantial harm and does not address the major policies that lead to problems in the U.S. corporate economy.